How to Avoid Workers' Comp Premium Overpayments

Kevin Ring can tick off a long list of examples of employers that overpaid their workers’ compensation insurance premiums: the Colorado health care company whose premiums unexpectedly skyrocketed, the Indiana contractor that paid expensive roofing-related premiums for clerical workers who never set foot on a construction site, and the North Carolina sawmill that overpaid its workers’ comp premiums by more than $400,000, to name a few.

As diverse as these instances are, they share the same root cause: workers’ compensation code misclassifications.

“Misclassifications can have a major impact on premium costs,” says Ring, the lead workers’ compensation analyst at the Institute of WorkComp Professionals in Asheville, N.C. The problem is pervasive—as many as 70 percent of companies overpay their workers’ compensation insurance premiums—and exacerbated by a complex classification system. More than 650 business and job codes are used to determine premiums, which apply for a 12-month period.

“It’s very important for an HR department to work with the insurance broker on code classifications,” notes Randy Sieberg, founder and principal of Workers Compensation Consultants in Columbia, Mo. “Different insurance companies can interpret the application of classifications differently, and you want to work that out ahead of time.” As an employer, you don’t want to find out about classification errors a year after a workers’ compensation insurance policy has gone into effect.

Yet this often occurs. In fact, Ring cites a case in which a Wisconsin auto parts manufacturer overpaid its workers’ comp premiums by roughly $12,000 annually for years due to coding errors.

To prevent costly surprises, David Twitchell, PHR, vice president of human resources at New Hampshire Catholic Charities, meets quarterly with his company’s workers’ compensation external administrator and the insurance carrier to review the policy, existing claims, related safety training and costs. “If there are any problematic situations, the meetings give us a chance to address them,” says Twitchell, a member of the Society for Human Resource Management’s HR Disciplines Special Expertise Panel.

A host of other workers’ comp concerns—including open claims and rating factors based on loss experience—compete for people’s attention. But assigning the wrong workers’ compensation code to a company or an individual employee may lead to higher premiums, directly or indirectly, which is why HR professionals should understand how misclassifications occur.

‘Complex’ Is an Understatement

When workers’ compensation experts explain how insurance premiums are set, they pepper their discussions with the phrase “There’s an exception.”

U.S. companies (except many in Texas) are legally required to maintain workers’ comp insurance. The National Council on Compensation Insurance (NCCI) is by far the country’s largest workers’ compensation rating and statistical organization. It sets and manages the classification codes for companies in all but 14 states. Of those exceptions, 10 of the states have independent workers’ comp bureaus, some of which incorporate NCCI codes, and four are “monopolistic” states with their own classification systems.

Business-type classification codes are assigned to companies in all industries except construction, agriculture and staffing services, where numerous employee codes are assigned to various individual employees.

Not surprisingly, those are the industries that tend to have the most classification errors. “Construction has a giant target on it because it is one of the only industries that allow the use of multiple classification codes,” Sieberg explains. For example, there are different codes—and corresponding premium rates—for wiring, plumbing and excavation jobs.

In industries that predominantly use business-type codes, there are also certain exemptions for individual job types (clerical, outside sales and drivers, in some cases). Individual employees and contractors in construction, agriculture and staffing companies generally have a single workers’ comp code classification (except when they have two codes because they perform two distinct types of work).

Insurance agents are responsible for assigning classifications, but they often misclassify due to their own oversights or their clients’ errors.

“To say that the entire process is complex is probably a serious understatement,” says Sieberg. However, much of that complexity is necessary, he notes. After all, the purpose of the system is to be as precise as possible in quantifying the risks of specific types of work.

Costly Errors

The NCCI’s stance is that proper classification is important, in part because errors can lead to imprecise quantification of risk, which ultimately results in some companies unfairly paying more or less for workers’ comp policies. When occupation codes are correctly assigned and kept current, “all employers are treated fairly and are not charged more or less than those who do similar types of work,” according to an NCCI spokesperson.

Code misclassifications generally are more of an issue for smaller companies—those paying less than about $500,000 in total premiums and those with fewer than 500 employees, according to Ring, who emphasizes that these are rough estimates and that there are exceptions. Larger companies often have alternative funding programs in place for workers’ compensation coverage, including forms of self-insurance.

Premium rates are expressed as a ratio of compensation. For instance, coverage for a clerical position might cost 30 cents per $100 of compensation, while coverage for a roofer could be as high as $30 per $100 of compensation. The cost of misclassification varies because it is determined by premium differences, the number of misclassified employees and the amount the misclassified employees earn, among other factors. Ring says the North Carolina sawmill’s $400,000 overpayment, which occurred over several years, is one of the largest he knows of.

While policy-mandated audits are designed to catch and correct overpayments within a 12-month period, they sometimes fail to do so.

Audits and Oversights

Workers’ compensation insurance policies typically require regular audits, which are usually conducted once a year by the insurance company. Their purpose is to determine the correct premium based on actual payroll. Premiums are initially set using payroll estimates for the coming year. If actual payroll is higher, the company likely underpaid its premium and will owe the insurance company the difference. If it is lower, the company likely overpaid and will receive a check from the insurer covering the difference.

In this way, the audits are more like a settlement process: After an audit, an insurer either cuts a check or sends an invoice.

Depending on their rigor, audits can also catch classification errors that cause unexpected and often more-significant underpayments or overpayments. The thoroughness with which audits are conducted varies, usually by company size, industry and the number of classification codes. Some audits consist of a mailed form that the company fills out. Others entail a phone call with an insurance company representative. More-involved audits include visits in which an insurance representative or its hired contractor conducts onsite interviews with managers and employees.

If someone within a company disagrees with the results of an audit, he or she should contact the insurance agent right away and explain why. The agent will then discuss the matter with the carrier. The disagreement may get resolved there. If not, a formal appeals process typically ensues, often initiated by the insurance company. This review, in most states, involves an NCCI inspection. If the company disagrees with the NCCI’s ruling, it can appeal to its state insurance agency; litigation may also be pursued.

Buyer Beware

The precision with which insurance agents and companies assign codes when a new workers’ comp policy is created also varies. Some agents have extensive knowledge of and experience with occupation classifications. Others do not. It is important to keep in mind that this type of insurance is mandatory for employers and a comparatively low-profit source of income for agents and insurers. An agent’s primary job is to sell insurance, notes Sieberg, and relatively few have deep knowledge of the complicated rules and regulations set forth by the NCCI and state agencies.

Many companies place too much emphasis on price, and too little on expertise, when shopping for workers’ comp policies. “For many businesses, workers’ compensation policies represent as much as 30 percent of all the money they’re spending on insurance, but they shop for it the same way they buy paper for their copy machines,” Ring says. “They make a bunch of calls, ask for a price and then take whoever is the cheapest. They pay no real attention to whether or not the people selling them this product have any expertise.”

In addition to the initial errors made when a new policy is created, subsequent classification errors routinely occur due to changes in the business and, in many companies, to individual jobs. A company that sheds its manufacturing operations and becomes a distributor may qualify for a new business classification linked to lower premiums. Likewise, a drywall installer who is promoted to a driver would qualify for a new occupational classification associated with decreased rates.

Signs of Classification Errors

There are often gray areas when it comes to assigning workers’ compensation classifications, says Kevin Cruz, senior associate with Encino, Calif.-based law firm Alpert, Barr & Grant. However, he encourages policyholders to be aware of the risks of premium underpayment as well as overpayment.

“You definitely should try to avoid overpaying premiums, but be mindful that the insurance company has a right, according to the policy, to audit your classifications and payroll,” Cruz says. “I recommend that companies cooperate with those audits.” If an audit identifies a misclassification, in most cases the insurance company simply corrects the error and adjusts the premium. For premium fraud to be present, an insurance company must establish intent. “If you’re cooperative,” Cruz says, “you’re avoiding the impression that a genuine mistake was actually intentional.”

How to Avoid Mistakes

HR professionals should develop a basic understanding of workers’ compensation classifications and recognize common causes of classification errors. To get started, Ring suggests the following actions:

Read your insurance policy. Even a quick read can produce results. The Wisconsin auto parts company Ring mentioned had $80,000 in payroll linked to an $8 per $100 occupation classification code. By reviewing its workers’ compensation insurance policy, the company saw that a significant portion of the payroll should be reclassified with a $3 per $100 code, which shaved $12,000 per year from its premium costs.

Ask your agent how the business and individual jobs are classified. If your agent is unhelpful or uninformed, conduct your own research or find a new agent.

Update your insurance policy each year. Businesses, jobs and payrolls change throughout the year, and workers’ comp insurance policies should reflect those modifications. Don’t let an agent copy the previous policy to use for an upcoming 12-month period.

Consider outside help. Workers’ compensation consultants can spot red flags and help companies negotiate a fair resolution with the insurance company.

Despite the complexity involved with workers’ comp classifications, Sieberg says the primary reason classification errors occur is simple: communication failure. “I can’t stress enough how many times we see a problem that could have been eliminated much earlier in the process through better communications by all parties,” he says.

It’s a cheap solution to what could be a very expensive problem.